IMF urges Japan to keep raising interest rates
The International Monetary Fund has urged Japan to continue raising interest rates gradually and avoid further fiscal easing, warning that reducing the consumption tax could weaken the country’s ability to respond to future economic shocks.
The recommendation comes as markets closely monitor Japan’s economic policy following Prime Minister Sanae Takaichi’s landslide election victory.
IMF supports Bank of Japan policy tightening
In its preliminary policy recommendations, the IMF said the Bank of Japan is appropriately withdrawing monetary stimulus that had supported the economy for years.
According to the IMF, gradual rate increases should continue until the policy rate reaches a neutral level. The organization expects that point could be reached around 2027 if current economic projections hold.
The Bank of Japan ended its massive stimulus program in 2024 and has since raised interest rates several times. In December last year, the central bank lifted its policy rate to 0.75%, the highest level in roughly three decades.
Inflation in Japan has remained above the central bank’s 2% target for nearly four years, strengthening the case for further policy normalization.
Government tax plans raise investor concerns
The IMF’s warning comes as Japan’s new government considers fiscal measures aimed at easing the cost of living. Prime Minister Sanae Takaichi has pledged to suspend the country’s 8% consumption tax on food for two years.
The proposal is part of a broader plan to support households, but investors worry that tax cuts and higher spending could worsen Japan’s fiscal outlook.
Late last year, Japanese government bonds and the yen came under pressure after markets reacted to concerns about rising fiscal risks linked to potential policy changes.
IMF warns about fiscal sustainability
The IMF cautioned that reducing the consumption tax could erode Japan’s fiscal space and increase financial risks. Even if the tax reduction were limited to essential goods and designed as a temporary measure, the country would still need to maintain fiscal discipline.
The organization recommended that Japan establish a credible medium-term fiscal framework supported by a clearly defined fiscal anchor.
Japan’s debt burden remains a major challenge
Japan carries one of the highest public debt levels in the world, exceeding 250% of gross domestic product. About a quarter of government spending is financed through borrowing.
According to IMF projections, interest payments on Japan’s debt could double between 2025 and 2031 as existing bonds are refinanced at higher yields.
Another challenge stems from the Bank of Japan’s gradual reduction of its balance sheet and bond purchases after years of large-scale monetary stimulus.
Implications for Japan’s financial markets
As the central bank scales back bond purchases, authorities will need to closely monitor liquidity conditions and investor demand in the government bond market.
If volatility threatens market stability, the IMF said the Bank of Japan should be ready to conduct targeted interventions such as emergency bond-buying operations.
The fund also welcomed Japan’s commitment to maintaining a flexible exchange rate for the yen, noting that currency flexibility helps absorb external shocks and supports the central bank’s focus on price stability.
As experts at International Investment note, the IMF’s recommendations highlight growing concern among global institutions about Japan’s fiscal sustainability in a rising interest-rate environment. Analysts say maintaining a balance between economic support and fiscal discipline will be critical for the stability of Japan’s financial markets in the coming years.